Why Bitcoin and alt coins will offer “a new money menagerie”

by on August 10, 2017 at 1:30 am in Economics, Uncategorized, Web/Tech | Permalink

That is the topic of my latest Bloomberg column, here is one excerpt:

Alt coins may be effective hedges for at least two reasons. First, the value of the coin may depend on how well the original rules for the coin were written, or how well it is governed in the case of managed coins like Ethereum or Ripple. Those factors may be fairly independent of what’s driving returns in traditional stocks and bonds, which in turn creates an opportunity for diversification.

Under these scenarios, alt coins are primarily stores of value rather than media of exchange. There is a notable tendency for exchange media to consolidate into a dominant currency in a given geographic region. But the very large number of financial assets in the world shows that thousands of stores of value can coexist and compete without much consolidation.

Second, alt coins to some extent are used for money laundering. If you think the world might be moving toward greater authoritarianism, the demand for money laundering could go up, to evade capital controls or asset restrictions. The value of alt coins would rise in turn, and that means alt coins would provide partial insurance against this very possible but unpleasant future path.

There is much more at the link.  Overall I believe it is a mistake to focus too much on the medium of exchange function of such coins (“Can I use it in the store?  I heard there are some food trucks taking Bitcoin!”, etc.).  Instead think of them in terms of services offered.  A new coin also may back, complement, and introduce a new protocol, though I didn’t have space to cover that in the column.

A few of you have asked me about the recent Bitcoin fork, here is one technical look at the issues.

I am struck by the notion that, of the two forked assets, the old-style, slow, and “immutable” Bitcoin retained most of the market value and trading interest.  While that happened for a few reasons, I wonder if the market isn’t telling us that, at least when it comes to selecting the most dominant asset, it prefers a “rigid coin” to a coin managed by a company such as Ethereum or Ripple, or to a coin “managed” by votes and forks.  In other words, the governance problems with coins may be larger than we had thought, and voting may deepen rather than solve those problems.  The market seems to like fairly rigid constitutions.  And for all the pledges made by company-run coins, is there really no way for those companies — in their post-founder futures if not now — to pursue their own interests over those of other coin holders and users?  Since Benjamin Klein (1974) or earlier, we have known that is a classic problem with non-convertible private monies.

To what extent does the market prefer the “dogmatism” of classic Bitcoin to the discretion of private management?  Not long ago, I had edged toward the view that Ethereum and its neat properties will displace Bitcoin, but now I suspect both kinds of coins will persist.

The brilliant Matt Levine will make your head spin.

1 prior_test3 August 10, 2017 at 1:51 am

‘alt coins are primarily stores of value rather than media of exchange’

Or at least the Platonic ideal of a store of value. Though it does seem we live in an essentially Aristotlean world, where a store of value actually requires at least a minimal physical existence beyond merely existing in a cloud.

2 JWatts August 10, 2017 at 8:24 am

“Though it does seem we live in an essentially Aristotlean world, where a store of value actually requires at least a minimal physical existence beyond merely existing in a cloud.”

Do you not know what a BitCoin is?

3 dan1111 August 10, 2017 at 8:32 am

When you phrase it like that you are bound to get a response like “Yes…[1000 words on what Bitcoin is and related topics without acknowledging the implicit critique in your comment]”. And you will have only yourself to blame :).

4 JWatts August 10, 2017 at 9:01 am

Agreed, prior_test’s motto is “If you can dazzle them with brilliance, then baffle them with bullshit.”

However, I think most readers are smart enough to start reading the long answer from him and figure out it’s bullshit. And frankly, it’s beyond his normal level of ignorance to claim that a store of value requires a physical existence, when the discussion is about a store of value that doesn’t have a physical existence. He’s literally arguing against the obvious facts.

Seriously, does anyone think that the trillions in Treasury Bonds are dependent on actual pieces of paper? When’s the last time anyone here demanded paper stocks from their broker?

5 dan1111 August 10, 2017 at 9:26 am

Obviously p_a supports the gold standard.

6 Thiago Ribeiro August 10, 2017 at 11:15 am

I support coinage of silver dollars at a fixed weight ratio of 16-to-1 against dollar coins made of gold. I am against “crucifying mankind upon a cross of gold”.

7 JWatts August 10, 2017 at 11:41 am

Price Controls? Well you’ve got a friend in Venezuela.

8 Thiago Ribeiro August 10, 2017 at 1:56 pm

I am for driving the moneychangers from the Temple before they wash their hands and crucify mankind upon a cross of gold. Brazil’s system is very unlike Venezuela’s.

9 JWatts August 10, 2017 at 4:23 pm

“I am for driving the moneychangers from the Temple before they wash their hands and crucify mankind upon a cross of gold”

So, you want a Theocracy?

10 Adrian Ratnapala August 10, 2017 at 6:41 pm

Well the connexion between information and physics is a deep matter, not well understood. But it seems that as far as humans, or any other denizens of this universe go, there must always be a physical substrate. A bitcoin can be stored in a home PC, a USB stick, a clould datastore or on a handwritten piece of paper.

But it must be stored.

11 ʕ•ᴥ•ʔ August 10, 2017 at 9:53 am

Bitcoin are the fidget-spinners of the financial and economic worlds.

12 msgkings August 10, 2017 at 12:11 pm

I used to think so, but no it’s a real thing.

13 JWatts August 10, 2017 at 4:24 pm

+1, me too. I still don’t really get the intrinsic value people assign it, but I don’t deny it just because I don’t understand the underlying psychology.

14 ʕ•ᴥ•ʔ August 10, 2017 at 5:56 pm

Fidget-spinners are real too, with otherwise serious people doing reviews. And of course a GDP of fidget-spinners driven by their “utility.” That doesn’t mean the utility is real or vital to most attracted to the shiny spinny objects.


15 dan1111 August 10, 2017 at 4:21 am

The Matt Levine piece is superb.

Tyler’s article was interesting too; it could be read as an explanation of why Bitcoin skepticism from a few years ago ended up being wrong.

16 BC August 10, 2017 at 8:22 am

Tyler’s comments on the money laundering angle are interesting. It doesn’t even have to be “money laundering” as much as protecting assets from government seizing or freezing more generally. Government may be able to shut down entire coin exchanges, but can it seize the coins of an individual without cooperation from the entire network? My (limited) understanding is no. Storing assets like stocks and cash electronically with a trusted authority like a bank or brokerage provides great convenience for trading and liquidating those assets, but the government can force that same central authority to cooperate in freezing and seizing. A way to store electronically tradeable assets beyond the reach of government would seem to be of great value.

One doesn’t even need to fear “greater authoritarianism”. Even in the democratic West, property rights and economic freedom are afforded less legal status than “fundamental” freedoms, civil asset forfeiture for example. Uber was the first (?) example of a broadly accepted private sector solution to a public sector problem (taxi licensing used to restrict competition) created from this dichotomy. Perhaps, altcoins could provide a second.

17 rayward August 10, 2017 at 6:33 am

Aren’t alt coins conclusive proof that the expectations of market participants are determined by beliefs (psychology) rather than market fundamentals? Indeed, investing based on market fundamentals is limited to a few old-timers: the future of Wall Street belongs to robots, and the future is now. It’s no coincidence that economic policy today is driven by rising asset prices, and the suspension of disbelief by investors (and not a few economists). Flights of fancy to Mars requires one to believe that gravity (and the laws of nature generally) no longer apply. There’s little doubt where we are headed, but the more important question is how we got here.

18 rayward August 10, 2017 at 6:45 am

Correction: “economic fundamentals” (not “market fundamentals”) at the end of the first sentence.

19 dan1111 August 10, 2017 at 6:47 am

A manned flight to Mars is definitely technically feasible. It’s much less of a technical leap than the original moon landing. We haven’t done it because of the cost.

20 Dick the Butcher August 10, 2017 at 8:06 am

True. Although, it may be not so much “robots.”

Barron’s thinks it’s more “passive investing” – index funds are not price sensitive, don’t do research – “. . . destructive to the growth-creating and consensus-building of free market capitalism.” Paul Singer.

Most of the stock market index record prices are concentrated in a small number (30?) huge, high-flyers. Look at their valuations.

It appears that some believe they will be time to get out before the fit hits the shan.

21 David August 10, 2017 at 6:54 am

That technical explanation article is highly biased, though perhaps unintentionally so. It repeatedly mentions that SegWit2x is not developed by Core developers, but that is not the case. The developers of SegWit2x/BTC1 are also, at least in large part, long-time Core contributors. Earlier attempts at blocksize hardforks were also put forward by former Core developers, including the lead maintainer at the time (talking about Bitcoin XT and Classic).

The article also claims that signaling was not intended as an upgrade mechanism (it was an enhancement to increase the stability of the network) without also mentioning that the 1MB blocksize cap itself was not intended as a permanent limit on network capacity. It was hacked in as a spam control prophylaxis and Satoshi himself wrote about his intention to raise it when it became necessary.

The bigger political moves and manipulation which were not referenced in the “technical” article have come from a company called Blockstream, which was founded by a Core developer, funded with $70 million (or more), and proceeded to employ nearly all of the top active contributors to the Bitcoin Core code repository. Soon thereafter, the scaling debate became an issue since SegWit is aligned with the business interests of Blockstream while a plain hardfork is not (since it wouldn’t do anything to enable sidechains which is how Blockstream intends to make money). Over the course of a few months, all the remaining top contributors to Core were forced out by the Blockstream-employed developers.

That is the point when alternative implementations were put forward by the outcast Core developers. Those proposals initially got a lot of support among the community and miners. However, the moderator who controls the main communication channels in the Bitcoin community started censoring that support among the community members. Additionally, nodes and miners supporting the hardfork found themselves under DDoS attack. Around this time, the CEO of Blockstream called several meetings with miners and the outcome was a pledge of loyalty to Core called the Hong Kong Agreement. The agreement specified that miners would run only Core and in return Core would deliver both SegWit and a blocksize increase hardfork. SegWit was delivered, the hardfork was not. That stalled scaling for over a year and led to the current situation. There’s more to the story, but those are some highlights.

22 Dick the Butcher August 10, 2017 at 7:59 am

It’s all good until the plumber won’t work for Federal Reserve Notes.

The Fed owns the monopoly on the “money menagerie.”

I don’t own Bitcoin or alt-coin. I prefer one-ounce, gold bullion alt-coins. I think (claxons!) they are more utile in a EMP or zombie apocalypse collapse.

23 Tanturn August 10, 2017 at 10:20 am

“The Fed owns the monopoly on the “money menagerie.””

I own gold too. It’s legal to own and legal to trade. Yet your plumber probably prefers the Fed “monopoly” to gold. Might tell you something.

24 cjcjc August 10, 2017 at 9:46 am

I know nothing (though I have tried!) about the technical side.
But what I do know is that an asset with the volatility of Bitcoin cannot possibly be considered a “store of value”.
*kicks himself for not having dipped a toe 5 years ago*

25 NatashaRostova August 10, 2017 at 10:42 am

Actually it can, it depends on its covariance with other assets.

26 Tanturn August 10, 2017 at 10:16 am

“thousands of stores of value can coexist and compete without much consolidation.”

Most of these either pay out real money or have intrinsic value. Bitcoin has a few practical uses, as a store of value which is harder for the government to seize and a currency for use in illegal transactions, but the vast majority of it is held in anticipation of the price increasing. Think about it, how much of those billions in bitcoin/altcoin value do you think is used for transactions (legal or illegal) or hiding money from governments? It will be in the textbooks of the future as a classic example of a bubble.

27 Nina August 10, 2017 at 10:30 am

Hi Tyler – Can you recommend books that may help me learn the basics about bitcoins?

28 Tyler Cowen August 10, 2017 at 12:30 pm

no books, just use Google and speak to people involved…

29 Nina August 10, 2017 at 1:28 pm

Thank you, Tyler. I appreciate you taking the time to respond to me.

30 Rick Hull August 10, 2017 at 4:03 pm

Try searching for: satoshi whitepaper

That would be from Bitcoin’s inventor, and if you work your way through it, you will have a solid foundation and myriad branching points for further investigation

31 Nina August 10, 2017 at 5:17 pm

Thanks so much Rick!

32 byomtov August 10, 2017 at 1:38 pm

alt coins are primarily stores of value rather than media of exchange.

I don’t really understand this. It seems to me that something with no practical use can only be a store of value if it is also a medium of exchange. Canned goods, bottled water, tools, etc. are useful in themselves. Bitcoin and dollar bills are not.

So how do they store value if they are not used for exchange?

In fact, is it not the case that it is the usefulness of a currency as a medium of exchange that makes it a store of value? Are these two functions independent of one another?

33 JWatts August 10, 2017 at 1:55 pm

“So how do they store value if they are not used for exchange?”

I think the key word is primarily. You are correct that any alt coin that isn’t exchanged rather frequently will probably not be a decent store of value. On the other hand an alt coin where there are a lot of daily transactions, but most of the transactions come from a small subset of the coins still fits the description.

“Are these two functions independent of one another?”

I would say the answer is No, but neither do they have a perfect correlation.

For an admittedly imperfect example, look at American currency, how often do $50 bills get involved in transactions? And yet, they are still a good store of value, because society treats them as worth 50 $1 bills.

34 byomtov August 11, 2017 at 4:25 pm

Depends what you mean by “a small subset.”

Your example of $50 bills is fine, but is that the same thing as a small subset of bitcoins, which are just electronic records? If the subset in question is really a subset of owners, or transaction counterparties, the story changes.

35 Adrian Ratnapala August 10, 2017 at 6:38 pm

In other words, the governance problems with coins may be larger than we had thought, and voting may deepen rather than solve those problems. The market seems to like fairly rigid constitutions.

When Satoshi Nakamura’s introduced Bitcoin to the world, his premise was that the coin needed a rigid constitution, enforced by code and game theory. And TC claim that the market is now validating this So it’s not so much that the “the governance problems with coins may be larger than we had thought”, but that rather the constitutional governance structure is working just as intended.

36 prankeapple August 10, 2017 at 7:59 pm

Ethereum isn’t run by a company. Its development is spearheaded by a non-profit foundation headquartered in Switzerland called the Ethereum Foundation, but there are multiple other competing clients users can utilize which aren’t affiliated with the Ethereum Foundation and which are perfectly functional. Furthermore, as Ethereum continues to mature as a platform, there are plans for its development to become ever more decentralized; centralization by a ‘benevolent dictator’ at the current time is simply the most efficient way to build the blockchain and push features out the door. Vitalik Buterin himself has said he’d like to hand off Ethereum to someone else/the community in ~5 years.

37 James Anderson August 11, 2017 at 11:15 am

Bitcoin has really stuck a level that’s unbelievable and it will be interesting to see where it all runs. I love doing trading, I feel it’s better and more secure way. I get great help from broker like OctaFX, as they have over 70 instruments to pick from with having LOWEST possible spreads at 0.1 pips for all major pairs, zero balance protection, swap free account and then there is 24/5 customer service available to help further with doing things.

38 James August 31, 2017 at 8:27 pm

I got screwed by the bitfinex issue described by Matt Levine….lost $1k :(.

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